The Relationship Between Corporate Social Responsibility and Earnings Management: An

Exploratory Study
Author(s): Yongtao Hong and Margaret L. Andersen
Source: Journal of Business Ethics, Vol. 104, No. 4 (December 2011), pp. 461-471
Published by: Springer
Stable URL: http://www.jstor.org/stable/41476320
Accessed: 16-09-2016 06:14 UTC

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J Bus Ethics (201 1) 104:461-471
DOT 1 0.1 007/s 1055 1-01 1-0921-y

The Relationship Between Corporate Social Responsibility

and Earnings Management: An Exploratory Study

Yongtao Hong Margaret L. Andersen

Received: 23 April 2010/ Accepted: 26 May 2011 /Published online: 16 June 2011
Springer Science+Business Media B.V. 201 1

Abstract In this article, we explore the relationship attention being paid to the managerial activities which can
between corporate social responsibility (CSR) and earnings lead to the manipulation of earnings. In this article, we
management (EM). Our CSR index, using KLD data, examine the communication process by investigating the
incorporates information from the following issue areas: the potential relationship between corporate social responsi-
community, corporate governance, diversity, the product, bility (CSR) and the quality of their financial reporting.
employee relations, the environment, and human rights. The results of accounting are an important part of the
Results show that more socially responsible firms have communication process companies engage into provide
higher quality accruals and less activity-based EM, both of information to their stakeholders. Any communication
which impact financial reporting quality. process has at least three parts: a sender of the message (the
company), the message (financial reports), and the receiv-
Keywords Accruals quality Corporate social ers of the message (the company's stakeholders). While
responsibility Earnings management Ethics KLD their objectives are not necessarily at odds with each other,
database the company has an incentive to influence the communi-
cation process to encourage particular actions from its
various stakeholders. Examples of this include encouraging
Introduction creditors and stockholders to supply additional capital
under favorable terms and the government to decrease
regulatory pressures on the firm.
Companies provide financial information to raise debt and
equity capital, as well as to comply with governmental Ethics plays an important role in this communication
process. In a recent academic paper, Reynolds and Yuthas
regulations and contractual requirements. External stake-
(2008) discuss whether companies engage in "ethical
holders assess the amount, timing, and uncertainty of future
communications"
cash flows, using information such as the earnings reported with their stakeholders. From the same
time period, a newspaper editorial cites the need for an
in the financial statements. They make investment and
credit decisions based on their assessment. Therefore, the
"ethical bailout," not just a financial one (Friedman 2008).
quality of the reported earnings plays an important roleThe concern about ethics in corporate communications, and
in the communication process between companies and actions, is widespread. Financial reporting is the commu-
nication process of interest in this article.
external stakeholders. Decades of empirical research have
focused on the factors influencing the quality of earnings, The rest of the article is organized as follows. In the
"Literature Review and Hypothesis Development" section,
specifically the accruals. However, there is also increasing
we discuss the motivation for companies to engage in
socially responsible actions, interpret earnings manage-
Y. Hong M. L. Andersen (El)
North Dakota State University, Fargo, ND, USA ment (EM) as a means of influencing the accounting
e-mail: Margaret.Andersen@ndsu.edu message to external stakeholders, and discuss the possi-
Y. Hong bility that these two influences (CSR and EM) are related.
e-mail: Yongtao.Hong@ndsu.edu Next, we identify all models and describe the variable

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 462 Y. Hong, M. L. Andersen

measurements in
and supplemented by thethe "Researc
long stream of empirical research
present our that finds that CSR and financial
results in performance
the are posi- "Resul
Finally, we tively related (e.g., Callan
discuss and Thomas 2009; Griffin and
limitations and
in the "Conclusion" section. Mahon 1997; Preston and O'Bannon 1997; Waddock and
Graves 1997).
Strategic philanthropy appears to combine all of these
Literature Review and Hypothesis Development motives for CSR. A cornerstone of strategic philanthropy is
that businesses and society are interdependent (Porter and
Corporate Social Responsibility Kramer 2006; Stewart 2006). Further, with good manage-
ment, firms can be socially responsible and turn that
responsibility into a competitive advantage for the firm
An early and influential voice in the CSR literature is that
of A.B. Carroll. In 1979, he proposed the following four-(Cohen 2009). Saiia et al. (2003) find that companies with
greater
part definition of CSR: "The social responsibility of busi- business exposure have higher levels of strategic
ness encompasses the economic, legal, ethical and discre-philanthropy. Thus, companies engage in CSR for many
reasons. In the next section, we discuss why companies
tionary expectations that society has of organizations...
(Carroll 1979, p. 500)." He subsequently identified the
may manage earnings.
discretionary component as philanthropic. In describing his
CSR pyramid, Carroll summarizes his ideas as follows: AEarnings Management
company engaging in CSR will work to make a profit, obey
the law, behave ethically, and be a good corporate citizen
Companies can influence the message conveyed to external
(Carroll 1991). users by modifying the actions they take and thus affect
their true economic reality, which is often referred to as
Drucker (1984) expanded on the perspective that prof-
itability and social responsibility are compatible. He is one
real earnings management (R-EM) (Roychowdhury 2006;
Bens et al. 2003). For instance, firms may decrease dis-
of the first to suggest that companies should ensure that
cretionary costs such as advertising and training to boost
their social responsibilities also become business opportu-
nities (Drucker 1984). As this idea has matured, it has
earnings. However, such an action will undermine the
become known as strategic philanthropy. firms' competitive power. R-EM is costly. In another form
Porter and Kramer (2006) identify four prevailing rea-
of EM, companies can adjust the accruals part of earnings
without inducing real economic consequences, often
sons for companies to engage in social responsibility. First,
society, in general, and many firms in particular, have
referred to as accrual-based earnings management (A-EM)
(Dechow et al. 1995). For example, firms can change their
believed that companies have a moral obligation to engage
estimates of warranty liabilities. This will change the
in actions for the benefit of all; whether or not these actions
accruals part of earnings but have no actual impact on
are profitable. Second, the concept of sustainability stresses
future cash flows. Accounting ME disguises the real eco-
the need for the firm's stewardship of the environment and
nomic conditions and lowers the quality of reported
the community. Third is the idea of a license to operate.
Governments, communities, and others give companies
earnings.
tacit or explicit permission to do business. Finally, being A simple example may help illustrate. Suppose shortly
socially responsible can enhance the firm's reputation. before the fiscal year-end, a company makes a $30 sale.
Porter and Kramer (2006) state that firms are socially Further, assume at the time of the sale, the company
responsible because it "will improve a company's image,receives $20 cash and records an account receivable (A/R)
strengthen its brand, enliven morale, and even raise theof $10. This $10 expected future cash payment is, of
value of its stock." These reasons for companies to engage
course, an accrual. If the company subsequently receives
in CSR can be viewed as attempts to influence external
payment of $10 cash in settlement of the A/R, the prior
stakeholders to view the company's financial reports
accrual "maps" perfectly into the current cash flow.
favorably. Now imagine that management decides to engage in
The stakeholder management theory states that compa- A-. Also, assume that past experience has indicated that
nies try to satisfy stakeholder expectations. This includes the company is likely to collect only $9 of the $10 A/R.
the recognition that some investors consider CSR in Management could manipulate earnings by overestimating
their investing decisions. The 2007 Report on Socially or underestimating bad debt expense. Only if the bad debt
Responsible Investing (SRI) Trends in the United States expense is recorded as 10% of A/R and the company does
reports that SRI assets increased from $639 billion in 1995 receive $9 cash will the accrual accurately map into the
to $2.71 trillion in 2007, an increase of more than 300%. cash flow. As just illustrated, EM affects accrual quality
This reason to engage in social responsibility is supported (AQ).

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The Relationship Between CSR and EM 463

In this simple correlation

example, between
management mayCSR
also an
c
engage in et al.
activities-based or(2008) report
"real" that
earnings com
man
(R-EM). With this approach, managers
more earnings may m
aggressiven
sales revenue by On the
modifying other
their hand,
credit Jense
terms. Fo
they may increase pelling
the description
time before of
payment the
is d
recent television company's
advertisements, equity is over
e.g., offer 0%
for a year or more! quence
As of EM
a result, is revenue
sales to increase
an
can be expected lead to
increase overvalued
but there willequity.
to be a p
ping of accruals
into cash performance
pany's flows. This simple
eventu
highlights the effects market's expectations.
of both accruals-based Th
man
and activities-based pp.
manipulations on it
44-45) describe the
as m
fo
earnings into cash flows. EM decreases
managers the inf
and the board of
content of financial confusion
reporting. and mixed signa
A vast number of ficult to limit the destructionempirical
scholarly of the core value of the paper
identified a variety firm...."
of methods and motives for
manage earnings (e.g., Companies
Merchant using accruals to manage earnings
and Rockness face 19
et al.
1998). We will negative
provide only
long-term consequences. Sloana brief
(1996) finds that overv
Healy firms with
and Wahlen (1999) large positive discretionary
report that accrualsmanagerssubse- u
affect contractual outcomes. Accounting
quently experience significant negative abnormal returns. infor
Beneish (1997) examines
frequently used to monitor contracts a number of companies
companiesusing h
variety of external aggressive accruals to manipulate
stakeholders; aearnings
common which were exam
use in debt covenants.subsequently
Also, charged by the Securities Exchange
managers have Com- been
inflate mission for to
earnings in order violating generally accepted
meet accounting prin-
budget goals (M
1990). Further, it has ciples.
been Finally, documented
accounting-based EM is generally that
believed man
use EM to increase to be unethical
their (Fischer and Rosenzwieg 1995;(Guidry
compensation Kaplan e
Healy 1985). In 2001). We state our first research
general, these EM actions are opp hypothesis in the alter-
innature, distort a nate form:
firm's intrinsic economic valu
be detrimental to future performance.
Hai There is a positive relationship between CSR and
Being aware of the existence of opportunis
accruals quality (AQ).
activities, there is a general interest in factors t
constrain these The R-EM
actions. literature identifies the following common
Governmental regulation
viewed as a potential ways to use activities to manipulate
constraint to earnings: boost sales
managerial m
tions of accounting by increasing price discounts
numbers or through more lenient
reported tocredit
the pu
terms; reduce discretionary
example, after the Enron and expenditures
other such as advertis-
headline-
ethical failures, theing Sarbanes-Oxley
or training expenses, and/or reduce reported costAct of was
goods sold by overproducing
July, 2002. The legislation was intended (Healy and Wahlen 1999;
to curb
fraud (Leder 2003). Fudenberg and Tirle 1995; Dechow and Skinner 2000).
We are interested inRoychowdhury
investigating (2006) finds evidence that
the these possibili
R-EM
CSR will inhibit EM. The
activities are notquestion of
optimal corporate responses interest
to economic
article is the circumstances.
following: does As a result, firms may suffer long-term
a company which i
responsible engage in consequences.
less EM? Due to (ethical
In and)our
long-run profitability
attempt to
this question, we issues, R-EM isboth
examine not an optimalA-
choice for firmsand
either. OurR-EM.
second
One possible response tohypothesis
our is theresearch
following: question
companies which are socially responsible actually
2 There is a negative relationship between CSR and
in more EM than companies
R-EM.
that are less socially
sible. In fact, firms may manage earnings using
There has been little
responsible actions. Petrovits prior researchprovides
(2006) to suggest an answer evi
to our research
firms time contributions to theirquestion. Labelle et al. (2010) point out
philanthropic f
in order to achieve there is a "near vacuum"
earnings of empirical literature
objectives. which
Manager
skillful may be ableaddresses the role ethics plays
to obtain both in controlling
higherEM. Their pr
results indicate that
greater credit in measures of a higher
CSR level of corporate moral
(deMaCarty
development
fact, deMaCarty (2009) argues is associated
that with higher
such qualitymanagem
financial
reporting.
may be the reason for the Theempirical
results of Chih et al. finding
(2008) are similar. of

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 464 Y. Hong, M. L. Andersen

They find thatflows.companies

A better mapping of accruals into cash flows would
with h
engage in less
reflect earnings smoot
higher quality accruals and, therefore, a higher
decrease/loss quality
avoidance. In
measure of earnings (McNichols 2002). We relate add
direct evidence
currentthat firms
accruals to cash flows from the time periods before which
have higher quality
and after, as well as the current accruals,
time period, using the w
responsible model in Dechow and Dichev
firms (SRFs)(2002) and Francis et al.engag
EM. (2005). Specifically, we measure accruals quality (AQ) as
the standard deviation of residuals cr(e) from Eq. 1 :

Research Design TCA, = Z?o ~ bjCFOf-i -f b2CFOf H- ?3CFOf+i

+ &4ARev, + ^PPE, + 6/, (1)
Measuring CSR where TCA = - ACL - ACF + ADCL + DAE;
TCA is the total current accruals; is the change in
To test our hypotheses on the relationship between CSR
current assets (Compustat data item 4); ACL is the change
and EM, we use information from the Kinder Lydenburg
in current liabilities (Compustat data item 5); ACF is the
and Domini (KLD) database to construct our measure of
change in cash flows (Compustat data item 1); ADCL is the
CSR. KLD has covered the S&P 500 since 1991 and
change in debt in current liabilities (Compustat data item
expanded its coverage in 2002 to the largest 3000 U.S.
34); DAE is the depreciation and amortization expense
publicly traded companies by market capitalization
(Compustat data item 14); CFO is the operating cash flows
according to their website (http://www.kld.com/research/
(Compustat data item 308); ARev is the change in revenues
stats/index.html). Hillman and Keim (2001) identify the
(Compustat data item 12); and PPE is the total property,
KLD database as the best source of social responsibility
plant and equipment (Compustat data 7).
measures available. Waddock and Graves (1997) identify
The residual s reflects the part of accruals that does not
several advantages to using KLD as a source of CSR
map into cash flows; and the subscript "t" denotes period
measures. The Kinder Lydenburg and Domini database
t. Following Francis et al. (2005), we add the variables
includes a large number of companies; currently there are ARev and PPE to reduce measurement errors. The standard
over 3,000 companies listed. These companies are
deviation of this error term from Eq. 1 is our measure of
reviewed by independent research analysts. These profes-
accruals quality. A higher a(e) indicates a poor mapping of
sional analysts consistently apply the same criteria to the
accruals into cash flows and suggests the presence of EM
companies. The results they report include strengths and
and unintentional forecast errors. A lower cr(e) shows high
concerns in seven issue areas: human rights, corporate
accruals quality and the absence of EM and fewer forecast
governance, diversity, employee relations, the environ- errors.
ment, product characteristics, and community relations. A
Following Roychowdhury (2006), we use the following
more detailed description of the strengths and concerns for
equations to estimate normal operating activities for each
these issues is provided in the "Appendix" section.
firm in the sample:
The sample consists of non-financial U.S. firms from
1995 to 2005. For each company in the sample, we sum the CFO(i^) = bo + biSALES(,-tf) H- b2ASALES(/) H~ e(,t)i
number of strengths and the number of concerns across the
(2a)
seven issue areas. We determine a CSR index for each
company by subtracting the sum of the concerns fromPROD^f)
the = ?o + &iSALES(;) + ?2 ASALES^/)
sum of the strengths. If the resulting CSR index is positive, 4- ASALES 4- e^t) (2b)
we identify the company as socially responsible. Across all
DEXP (,,) = bo + fti SALES (-i) + (2c)
seven issue areas, this socially responsible company has
more positives (strengths) than negatives (concerns). If where
the CFO is the cash flow from operations; PROD is the
CSR index is zero or negative, we classify the company production
as costs, the sum of cost of goods sold and the
less socially responsible. change in inventories; DEXP is the discretionary expenses,
the sum of advertising, R&D, and SG&A expenses;
Measuring Accruals Quality (AQ) SALES is the sales revenue, and ASALES is the change in
sales revenue.

The abnormal CFO (R_CFO), abnormal PROD

Our measure of accruals quality is based on the argument
(R_PROD), and abnormal DEXP (R_DEXP) are computed
that accruals are one of the two components in earnings
as the difference between the actual values and the normal
(the other one is cash flows) and contain management's
levels predicted by Eqs. 2a-2c. We use these abnormal
forecast and estimation of past, current, and future cash

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 The Relationship Between CSR and EM 465

measures proxies data

as foritem 308); <r(NI)
R-EM.is the standard deviation
In of net order to m
preting the resultsincomeeasier,
(Compustat data item (18); and
we FreqNNI ismultiply
the R_
R_DEXP by negativefrequency
one. of negative net income.
Then, if firms whic
socially responsible In addition
are using to our test variable CSR, we includeactivities
real control to m
variables in Eq.
earnings, they will have 3. Prior research (Dechow
higher and Dichev
R_CFO, R_PROD
R_DEXP than SRFs. 2002; Francis et al. 2005) has shown that these control
variables - LnOC, size, cr(Sales), <r(Cash), <r( N1) and Fre-
Model Selection qNNI - affect the standard deviation of accruals residuals
(j(e).
We investigate whether more socially responsible corpo- To control for the outlier effect, the extreme values of
rations will have higher or lower quality accruals. the
Wedistribution are winsorized to the 1st and 99th per-
model the association between accruals quality and CSRcentile
in before we run the model in time-series at the firm

Eq. 3: level. The time-series regression requires eight consecutive

firm-year observations. This provides at least six estimated
<r(e),= bo + b'CSRt + Z^LnOC, + Z^Size,
accruals residuals to allow us to compute the standard
+ b4d(Sales),+b5<r(Cash),+b6<x(M),+&7FreqNNI,
deviation of the residuals.
+ />

(3)
where LnOC is the natural log of operating cycles, calcu-
lated as 360/(Sales/Average Accounts Receivables) + 360/
(Cost of Goods Sold)/(Average Inventory); Size is the log
of total assets (Compustat data item 6); <r(Sales) is the
standard deviation of sales (Compustat data item 12);
Sample Selection
Table 1 Panel A summarizes the sample selection process.
To test our hypothesis, we obtain non-financial US sample
firms from the Compustat North America Tape and merge
this data set with the CSR data from the KLD database. We

-(Cash) is the standard deviation of cash flows (Compustat exclude financial firms from our sample because their

Table I Sample selection and distribution

Panel A: Sample selection

Firm-years

Initial non-financial Compustat sample merged with KLD data 1991-2007 26,589
Less: Firm-years with incomplete summary KLD data before 1995 -4,547
Less: Firms with less than 8-year observations - 1 1 ,849
Firm-years available 10,193
Firm-years after computing accruals quality 8,078
Panel B: Sample distribution

Year Full sample No. of socially responsible firms No. of less socially responsible firms

1995 307 147 160

1996 314 165 149
1997 333 167 166
1998 346 169 177
1999 372 194 178
2000 401 206 195
2001 621 239 382
2002 657 251 406
2003 1,577 395 1,182
2004 1,675 384 1,291
2005 1,475 340 1,135

Note The second column of Panel

firms, i.e., firms with a CSR ind
diversity, employee relations, env
less socially responsible firms, th

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 466 Y. Hong, M. L. Andersen

earnings are of Descriptive

a different Statist
nature
The initial merged sample has 26
ther reduce ourTable 2
sample presents
size by 4,
incomplete Panel
CSR dataAbefore
shows tha
199
years are lost uals
due with
to thea mean
lack os
required by operating
the accruals cycle
quality(
yields 10,193 deviation
firm-year of sales
observ
accruals standard
quality based deviation
on Eq. 1,
tions to test standard
our deviatio
hypothesis.
We divide the frequency
sample into of nega
SRFs,
CSR index, and lessare
data SRFs which
compara
than or (2002).
equal
to zero. However,
The SRFs
while the less to
ob (natural
SRFs havelog of
5,421
two and
subsamples in Dichev
the (2002).
univariate
stable income and
Sample a sample
Distribution with larg
significant relatio
Table 1 Panel A shows
careful examination of Panel
the reveals that CSR is
distribu
report the significantly negatively
number of correlated
firmswith <(). This
in providesthe
the less
SRFs initial
(LSRFs) in
support for HAi. Consistent with thecolumn
findings in
respectively. Dechowgeneral,
In and Dichev (2002) and Francisthe
et al. (2005), sam
all
years. control variables
However, the are significantly
number correlated with the <r(e)
of S
This decrease and most of them (except OC)
implies moreare significantly correlated
social
after 2003. with CSR. Multicollinearity would also work against

Table 2 Descriptive data

Panel A: Descriptive statistics

Variable Mean Standard deviation Lower quartile Median Upper quartile

a(e) 0.04 0.03 0.02 0.03 0.05

OC 122.43 77.73 72.06 108.47 153.11
Size 7.41 1.59 6.27 7.39 8.50

r(Sales) 0.15 0.14 0.06 0.11 0.18

flr(Cash) 0.05 0.04 0.02 0.04 0.06
<j(NI) 0.05 0.07 0.01 0.03 0.06
FreqNNI 0.18 0.28 0.00 0.00 0.20

Panel B: Spearman correlation between test

Variable CSR <() Size <r(Sales) <r(Cash) <7(NI)

) -0.04***
0.00 0.20***

Size 0.06*** -0.34*** -0.18***

r(Sales) -0.05*** 0.36*** -0.01 -0.20***

j(Cash) -0.02* 0.50*** 0.17*** -0.42*** 0.43***
<t(NI) -0.04*** 0.42*** 0.21*** -0.35*** 0.37*** 0.60***
FreqNNI -0.09*** 0.28*** 0.08*** -0.24*** 0.19*** 0.38*** 0.67***

***, **, * indicates significance at the 1, 5, and 10% levels, respectively

cr(e) is the standard deviation of unexpected accruals from Eq. 2; is the op
Receivables) + 360/(Cost of Goods Sold)/(Average Inventory); Size is the log of tota
is the standard deviation of cash flows; <r(NI) is the standard deviation of net incom
if a firm's social responsibility index is greater than 0, and 0 otherwise. The CSR

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 The Relationship Between CSR and EM 467

finding a significant (7.86%) suggests that a morebetween

relationship socially responsibleCSR
envi- and
quality (&()). ronment may curb EM and supports for HA1.
The results reported in Table 3 also provide evidence
relating to R-EM and support for HA2. LSRFs have sig-
Results and Discussion nificantly higher values of R_CFO, R_PROD, and
R_DEXP than SRF. Recall that higher values for these
Earnings Management and Accruals Quality measures indicate a greater discrepancy between the
observed and predicted values. These discrepancies are
likely due to managerial actions taken to manipulate
Earnings management, and thus the quality of financial
earnings such as boosting sales by granting more liberal
reporting, is a complex construct which has been measured
credit
in a variety of ways. In the literature, the absolute value of terms, reducing cost of goods sold by overproducing,
total accruals (AbsAccr) has been used as a proxy for EM;
or increasing income by decreasing discretionary expenses.
These R-EM activities negatively affect the quality of
the absolute value of discretionary accruals (AbsDAccr)
has served as a more refined measure of EM (e.g., Jones financial reporting of these firms.
1991; Dechow et al. 1995; Kothari et al. 2005). In Table 3,Finally, for our proxy for EM, <r(e), we find a similar
we report the results of comparing three measures ofsignificant
EM difference between SRFs and LSRFs. That is,
between firms classified as socially responsible (SRFs) LSRFs
and have a significantly higher a(e) (8.62%) and thus a
those identified as LSRFs. significantly lower accruals quality than do SRFs. This
suggests SRFs have higher accruals quality, and higher
First, Table 3 shows there is no significant difference in
the absolute value of total accruals (AbsAccr) betweenquality financial reporting, than LSRFs.
SRFs and LSRFs. This result suggests that SRFs report a Dechow and Dichev (2002) point out that improved
similar dollar amount of accruals as do LSRFs. This does accruals quality could be attributed to more accurate
not hold, however, for the other two measures of EM. SRFs
management forecasts and estimates as well as less EM. If
the measure AbsDAccr accurately captures EM and if its
have significantly lower (absolute value) discretionary
accruals than do LSRFs. This significant difference
impact on the current portion of EM is proportional, the

Table 3 Comparison of accruals, discretionary accruals, and accruals quality between socially responsible and less socially responsible firms

Variable Less socially responsible Socially responsible Difference15 t Value p Value

firms (LSRFs)a firms (SRFs)
(N = 5,42 l)c {N=2,651) (LSRFs-SRFs)

AbsAccr 0.0719 0.0704 0.0014 0.89 0.37

AbsDaccr 0.0508 0.0468 0.0040 2.74 0.01***
R_CFO -0.0369 -0.0661 0.0291 12.34 <0.01***
R_PROD -0.0089 -0.0559 0.0470 11.39 <0.01***
R_DEXP 0.0706 0.0598 0.0109 2.00 0.04**
(e) 0.0402 0.0367 0.0035 5.19 0.00***

Table 3 compares the mean difference of proxies fo

proxies for R-EM (abnormal operating cash flows,
deviation of total current accruals) between social
AbsAccr is the absolute value of total accruals (Ac
absolute value of discretionary accruals (Daccr), wh
estimated using performance controlled modified
operating cash flows, which is the residual obtained
cost of goods sold plus the change in inventories), w
discretionary expenses (the sum of advertising, R&
<j(e) is defined in Table 2
***, **, * indicates significance at the 1, 5, and 10
a Socially responsible and less socially responsible
larger than 0, a firm is labeled as socially respons
b The difference is computed as less socially respo
R_CFO, R_PROD, and R_DEXP indicate that LSRF
firms have lower accruals quality than SRF firms
0 We report the number of less socially responsible

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 468 Y. Hong, M. L. Andersen

decrease in EM
residuals impliesexplains
an improved mapping of accruals into app
increase in the
cash flows; SRFs' accruals
in another words, more SRFs provide higher
91.1%). The remaining portion,
quality accruals in their reported financial statements. Our
the result of research hypothesis HAipredictions
better is supported. a
Consistent with Dechow and Dichev (2002), we find a
Accruals Quality and
significant and Corporate
negative coefficient for size, but significant S
positive coefficients for the operating cycle (LnOC), the
In addition to standard
the deviations of sales (<x(Sales)), of cash flows tes
univariate
provide direct(<r(Cash)) and of net income (<x(NI)), and
evidence of the frequency
the of as
quality and negative income
CSR in (FreqNNI). This result implies that
Table 4. larger We
((), on the companies havedummy
CSR higher accruals quality, represented by
varia
other lower d(e). The volatility factors
confounding in sales, cash flows, and net doc
Dichev (2002).income,
The as well as the estimated
frequency of negative income appear co
tive and to lower accruals quality.
significant. The above resultsresult
This indicate that s
more social CSR, the variable of interest, has incremental explanatory
responsibility have a
of current accruals residuals. A low standard deviation of power over the control variables in explaining the
improved accruals quality.

Table 4 Regression of accruals quality on corporate social

Robustness Tests
responsibility

a(e' = bo -f- b' CSR/ + + Z^Size,

In the extant literature, there is no agreement on the mea-
4- 4<7(Sales), + b5o(C ash), + ^(NI), + ^FreqNNI, + st
surement of CSR. We net each firm's strengths and con-
Variable Estimated coefficient
cerns across seven issue areas as reported in the KLD
Intercept 0.018*** database. This method may increase the noise in our
(t value) (6.37) measure of CSR. To refine our measure of CSR, we replace
CSR -0.001** the CSR index dummy variable with all of the component
( t value) (-2.20) measures of CSR in Eq. 3 and rerun the regression. The
LnOC 0.005*** untabulated results show that only corporate governance,
(t value) (10.20) the environment, the product, and human rights have
Size -0.002*** incremental explanatory power over the control variables.
(rvalue) (-11.4) We recalculate the CSR index by adding all strengths and
subtracting all concerns in only these four issue areas. We
a(Sales) 0.036***
(t value) (16.01)
then replace the CSR index with the refined CSR index
(RCSR) in Eq. 3.
j(Cash) 0.159***
In Table 5, we report the result of regressing <() on the
(/ value) (17.58)
RCSR index. The estimated coefficient of RCSR is nega-
cr(NI) 0.040***
tive and significant at the 1% level, whereas the coefficient
(t value) (6.27)
of our original measure of CSR is negative and significant
FreqNNI 0.008***
at the 5% level. The adjusted R 2 also increases slightly
(t value) (5.89)
from 28.8 to 29.0%. These results indicate that the RCSR
No. of observations 6956
index better reflects the impact of social responsibility on
Adjusted R 2 28.8%
the quality of accruals. They further suggest that the fol-
***, **, * indicate significance at the 1, 5, and 10% levels, lowing issue areas play a key role in measuring CSR:
respectively
corporate governance, the environment, human rights, and
In Table 4, we examine the impact of corporate social responsibility product characteristics. The results again support HAi-
(CSR) on accruals quality using a multiple regression model. The
dependent variable is the standard deviation of current accruals
residuals, a(e). A higher o(e) indicates a poor mapping of accruals
into cash flows, namely a lower accruals quality, vice versa. Our Conclusions
interested test variable is CSR. An estimated significant positive
coefficient implies that socially responsible firms report higher quality
In the wake of a new wave of financial scandals since the
accruals

<() is our measure of AQ and is defined in Table 2; CSR index is

start of the new millennium, the quality of financial
described in Table 1; LnOC, Size, a(Sales), <r(Cash), <r(NI) and reporting has received renewed scrutiny. EM reduces the
FreqNNI are defined in Table 2 quality of financial reporting. This article addresses two

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The Relationship Between CSR and EM 469

Table 5 Regression of researchquality

accruals could advance on
our understanding
refined by providing
measure of
porate social responsibility more refined measures of these ideas. Similarly, method-
a(e)t = b0 + biRCSR, + ological improvements
b2LnOC, + b3Swould be helpful.
ize, + b4a( ModelsSales),
of the
+ ^(Cash), + fc6<KNI), complicatedqNNI,
+ b7Fre relationships
-famong
et these constructs would
Variable Estimated coefficient allow additional insights and would be very useful.

Intercept 0.019***
(t value) (6.95) Appendix: Components of the Strengths and Concerns
for the KLD Issue Areas
CSR -0.003***

(t value) (-4.17)
LnOC 0.005***
Community

(t value) (10.10)
Size -0.002***
Strengths:

(/value) (-12.1) Charitable giving

ff(Sales) 0.036*** Innovative giving
(t value) (16.01) Non-US charitable giving
d(Cash) 0.157*** Support for housing
(t value) (17.34) Support for education
<t(NI) 0.040*** Indigenous peoples relations
(t value) (6.24) Volunteer programs
FreqNNI 0.008*** Other strengths
(t value) (5.91) Concerns:
No. of observations 6956
Investment controversies
Adjusted R 2 29.0%
Negative economic impact
***, **, * indicate significance at the 1, 5, and 10% levels,
Indigenous peoples relations
respectively
In Table 5, we repeat the analysis done in Table 4, but using the
Tax disputes
Other concerns
refined measure of corporate social responsibility, our RCSR index.
The dependent variable in the multiple regression analysis is again
<r(e), our measure of accruals quality
g(e) is our measure of AQ and is defined inCorporate
Table 2; Governance
RCSR = 1 if a
firm's social responsibility index is larger than 0, and 0 otherwise.
Refined social responsibility index is the Strengths:
sum of a firm's social
responsibility indicators, including corporate governance, environ-
ment, human rights, and product, provided by Limited
KLD compensation
database; LnOC,
Size, <r(Sales), a(Cash), <r(NI), and FreqNNI are defined
Ownership in Table 2

Transparency
Political accountability
forms of EM: accruals based and activity
Otherbased.
strengths Our paper
contributes to the literature by examining both using the
Concerns:
same sample and time-frame; thus providing a more
complete picture of EM. Our sample consists
High of non-
compensation
financial U.S. firms from the time period 1995-2005.
Ownership
Consequently, any conclusions must Accounting
be about American
Transparency
firms without generalizing to international firms.
Political
Our paper also begins to fill the vacuum thataccountability
exists in the
literature investigating the role of Other
ethics in financial
concerns

reporting. We find evidence that firms which engage in

CSR are less likely to manage earnings. Although our
Diversity
paper contributes to this emerging literature stream, much
remains to be done.
Strengths:
Ethics, CSR, EM, and financial reporting quality are
complex constructs. It is difficult to operationalize such CEO
concepts; yet empirical research demands it. Future Promotion

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 470 Y. Hong, M. L. Andersen

Board of Directors Human Rights

Work/Life benefits
Women and minority contracting Strengths:
Employment of the disabled Positive record in South Africa
Gay and lesbian policies
Indigenous peoples human relations
Other strengths
Labor rights
Concerns: Other strengths
Controversies Concerns:

Non-representation South Africa

Other concerns
Northern Ireland
Burma

Employee Relations Mexico

Labor rights
Strengths: Indigenous peoples relations
Other concerns
Union relations
No-layoff policy
Cash profit sharing Product

Employee involvement
Retirement benefit Strengths:
Health and safety
Quality
Other strengths R&D/Innovation
Concerns: Benefits to economically disadvantaged
Union relations
Other strengths

Health and safety Concerns:

Workforce reductions
Retirement benefit
Product safety
Other concerns
Marketing/contracting
Antitrust
Other concerns
Environment

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